Bailout Perspective

The Bush Administration and Congress are hammering out an agreement on a $700 billion financial bailout. Rep. Barney Frank predicted a deal by Sunday. Here are several articles to provide some perspective.

The Paulson Plan Will Make Money for Taxpayers
By Andy Kessler, Wall Street Journal, 9/25/08

Kessler’s analysis leads him to conclude that the United States Treasury could “net a trillion dollars and maybe as much as $2.2 trillion.”

What’s the Real Cost of the Bailout?
By Brett Arends, Wall Street Journal, 9/26/08

Arends agrees: “…. the Treasury will certainly get some of its money back and will probably get most.” He goes on to say that the Treasury “could make an absolute killing.”

Bailout Cost Unknown – CBO
By Jeanne Sahadi, CNNMoney.com, 9/24/08

Because the government will be acquiring assets having underlying value, Peter Orszag, CBO Director, believes the ultimate cost of the bailout will be much lower than the $700 billion.

What We Learned From Resolution Trust
By William Seidman and David C. Cooke, Wall Street Journal, 9/25/08

Seidman and Cooke ran the FDIC and RTC during the savings and loan crisis. They remind us that managing the assets to be acquired under Treasury’s proposal will be a complex and difficult process.

This isn’t Armageddon
By Geoff Colvin, Fortune, 9/25/08

Colvin sees our system having a “self-correcting impulse” to successfully adapt to dramatic change. Hopefully it will be for the better.

Buffett Buys Into Goldman Amid Wall Street Losses
By Erik Holm, Bloomberg, 9/24/08

While Buffett negotiated an excellent deal for himself, I believe his investment is a strong expression of confidence. As Michael Yoshikami, president and chief investment strategist for YCMNet Advisors, said, “…. this suggests the world is not coming to an end.”

Fast Tracking for Ideas

Through all of the current turmoil Coca-Cola’s business and share price have been doing just fine.

Fast Track results: Coca-Cola (KO) failed 2 of the 8 categories, and is a potential idea that’s worth the time to thoroughly research.

Key points:

1. Coca-Cola generates lots of cash. The company delivered free cash flow of $5.5 billion in 2007, up from $4.6 billion the year before. Although down $203 million in the first six months of this year, free cash flow was still strong at $2.3 billion.
2. Cash is growing on the balance sheet. Cash and marketable securities totaled $6.9 billion at the end of the second quarter, an increase of $2.5 billion from year-end 2007.
3. Coca-Cola is conservatively capitalized with long-term debt as a percentage of total capital of only 11.0%.
4. Earnings per share surprised on the upside for the last four quarters, and Street estimates have been stable. Second quarter earnings came in at $1.01, for an 18.8% gain. Worldwide unit case volume grew 3%, with international up 5% and North America flat despite a difficult economy.
5. Warren Buffett’s Berkshire Hathaway owns 8.6% of Coca-Cola’s outstanding shares.

The Company Stock Risk Profile Fast Track is a research tool for quickly and easily screening stocks for potential ideas. Fast Track is comprised of 10 key categories incorporating fundamentals, valuation and how management and the Street feel about the stock. I like to see a stock fail no more than 3 categories before putting the stock through the complete 50-category Company Stock Risk Profile research process. Most important, whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen before buying.

Mark to Market Contagion

There hasn’t been much discussion about Financial Accounting Standard 157. But I believe it has been a principle underlying contributor to the current financial crisis, and needs to be modified. John Berlau wrote an excellent article on this in last weekend’s Wall Street Journal.

A Different View of Risk

I posted this article on March 12, 2008 . I thought it would be worthwhile repeating.

World economic collapse is imminent. 1929 is just around the corner. My stocks will never stop going down. I can’t take this anymore, and I’m getting out now. This is a new age for the economy and the stock market, and there’s no way stocks are going down. Everyone else has been making a lot of money in the stock market, and I’m not going to be left out. Feel familiar? These are examples of strong emotions that can push you into making bad investment decisions. However, these same emotions can be your allies, and a resource that you can use to take advantage of investment opportunities.

The stock market is like riding a wave up and down. Sometimes the wave can be dramatic and last a long time before it crashes or takes you up. While the market seems to extend itself, that is go beyond what seems reasonable, on the upside and downside, it always changes direction. While this may seem obvious, it takes a lot of emotional strength to fully embrace this fact when you’re feeling great and complacent when the market is soaring, and it seems that it will never end, or when you’re feeling fear and panic when the market is dropping rapidly, and it seems it will never stop falling.

Are you on the verge of selling all of your stocks because you cannot take the falling prices anymore causing you to panic? Or, are you about to buy stocks, possibly stocks with a high degree of risk, because you feel that all’s well with the stock market, and there’s no way anything can go wrong? Are these the extreme emotions that are really behind the investment decisions you are about to make? Are you about to sell at the bottom of the market or buy at the top because you are caught up in your emotions?

Get a pencil and paper and draw an elongated S shaped curve. Write Exuberance at the top and Fear and Panic at the bottom. These extreme emotions represent market tops and bottoms. To the right of this graph draw a vertical line and label it Risk. Write the word Highest at the top of the line and the word Lowest at the bottom. I call this the Exuberance / Fear and Panic Graphic.

You must understand risk within the context of your emotions. You are putting your money at the highest risk of losing it when you are the most comfortable and complacent about your holdings, when you are exuberant. Risk is at its lowest level just at the time when you are the most negative about the market’s outlook, when you are feeling fear and panic. Objectively recognizing your emotions, you can then turn your emotions and the graph upside down with Exuberance at the bottom and Fear and Panic at the top. Seeing risk with new clarity, you are able to make better investment decisions to protect your capital and take advantage of opportunity.

What action should you take when you are able to gather the emotional strength to turn the graph upside down? Be afraid of the market at the top of the graph. Turning exuberance into fear, sell your stocks and be entirely in cash. If you find yourself at the bottom of the graph, transform your fears into excitement about finding stocks to buy. Put cash to work towards being fully invested in stocks.

There are various methods of valuing markets, among them price / earnings ratios, dividend yields, earnings yields, sentiment indicators, and technical analysis or charting. These methods look outward. I’m proposing that you also should look inward at yourself with the aid of the Exuberance / Fear and Panic Graphic as another, albeit unconventional, approach.

A successful investor is objective, disciplined, and has a clear understanding of risk. The Exuberance / Fear and Panic Graphic helps you to objectively examine your emotions, attain the discipline not to get caught up in the wrong emotions at the wrong time, and to recognize the real risk inherent in your investment decisions.